Tuesday, September 25, 2012

When deciding upon a firm’s record retention procedures, it would be wise to consult federal and IRS regulations and state and local government record retention requirements. The IRS generally must assess additional tax within 3 years after the due date on a return. (So, keep records for 3 years.) A period of 6 years applies if the taxpayer omits items of gross income that in total exceeds 25 percent of gross income reported on the return. (Therefore, keep records for 6 years.) If a fraudulent return is filed or no return is filed, there is no limit to the period the tax can be assessed. (So, retain records permanently.)*

Thursday, September 20, 2012

If you’re like most owners of growing firms, you might wonder about the best way to protect your personal assets and conduct your daily activities. For some businesses, forming a corporation is the best solution. Others benefit most from the creation of a Limited Liability Partnership.

Suppose that you are the sole proprietor of a retail firm and a customer falls and gets hurt in your store. Your personal assets, such as your home, could be used to satisfy business litigation awards. When you have a general partnership (two or more people conduct a business), partners are not only liable for themselves, but also for actions of other partners. Insurance policies can protect you up to a certain point, but without a formal way to conduct business, you might still be open to risks.Limited Liability Partnership (LP or LLP)

This type of entity is a more formal way of doing business than a general partnership. Limited partnerships include both general and limited partners. Limited partners are usually investors with not much say in the business. An LLP can be formed after a general partnership has been set up and is working well. For example, a father and son own a business using an informal general partnership setup. However, now they need funds to make improvements and to open a new branch. While other family members and friends might be willing to help out, they’re not interested in the risks involved – so they choose to be limited partners.

The LLP is not a separate entity as far as taxes are concerned. This means that the LLP doesn’t pay separate income taxes, and profits/losses flow directly into partner’s tax returns. Note that an LLP is required to file an annual information return using Form 1065 and K-1s to all partners.

The rules about opening an LLP and documentation vary by state. Check out with the Secretary of State or other department for registration and compliance requirements. In California, the LLP structure is used primarily by certain professional services, and firms must pay an annual fee of $800.

One of the main advantages of an LLP is that it’s easy to attract investors, who might become silent partners without dissolving the original general partnership. On the other hand, the chief disadvantage of this type of structure is that you still have general partners who have liability over the business. Death of any partner dissolves the partnership.

Corporation

A corporation is a separate entity created at the state level. A corporation has rights and liabilities that are separate from the owners, shielding them from personal liability for business activities – a major advantage of a corporation. If a product hurts a customer and he sues, corporate owners are not at risk of losing their assets. A corporation has stockholders as owners, and it distributes profits and losses through dividends. Income doesn’t automatically flow through the owners.

It’s easy to transfer ownership through transference of stocks, allowing for more flexibility and the possibility of endless life. When a stockholder dies, the effect on the business is not as high as in the case of a sole proprietorship or a partnership. A corporation is an older, more traditional entity conducting business in the United States. Banks and investors tend to be more comfortable with a corporation rather than a Limited Partnership or Limited Liability Company.
Corporations file separate tax returns and pay taxes at their own rate. This often causes the problem of double-taxation of owners, who are taxed on dividends while corporations are taxed on earnings. Certain corporations do qualify with the IRS to be S-Corporations and are able to avoid the corporate taxation.

Professionals, such as doctors and attorneys, form professional corporations that offer lower liability protection for negligence or malpractice. This sub-type of corporation is preferred when compared to a general partnership, where professionals are liable for the malpractice of other owners.

A disadvantage of corporations is the work involved dealing with specific legal and financial requirements at both state and federal levels, such as holding annual members meetings. Also, some states charge corporations fees. For example, corporations operating in California pay $800 a year in fees even if they have losses or are based in other states.

Limited Liability Company (LLC)

LLCs are a very popular structure for a firm because it’s simple and easy to set up, providing business owners with flexibility not available with the other types of entities. It allows the benefits of liability protection similar to a corporation and it offers the option of a “pass-through” taxation, like a partnership.

An LLC with only one owner can be considered to be a “disregarded entity” with profits and losses flowing directly into the personal tax return of the owner. The LLC can also choose to be treated as a corporation for income tax purposes – this level of flexibility can be very appealing to many business owners. There is no need to hold annual meetings or to submit minutes with this type of entity. However, it does need to have bylaws or an operating agreement to avoid losing liability protection.

An LLC is not a corporation, and its creation is a bit different than a corporation. Some states, such as California, don’t allow for licensed professionals to form professional limited liability companies (PLLC). Certain circumstances, such as making the company insolvent because of excessive partners’ distributions, can make owners personally liable for the debts of the LLC.

Note that when a member of the LLC dies, the LLC may dissolve, depending on the state the company resides in and its operating agreement. Also, note that an LLC is a relatively new form of business and state laws continue to change regarding this type of entity. Banks and investors may prefer to invest in a corporation that they are more familiar with than an LLC entity.

As you consider the types of entities available for business owners who want to formalize their operations and to protect themselves from liability, it’s always a good idea to talk to professionals familiar with the various options. Don’t wait until your assets are at risk to take care of the liabilities of owning a business – be proactive and start to consider your options now.

Tuesday, September 18, 2012

The very assets that make entrepreneurs successful can turn into handicaps when their business ventures take off and they assume the role of boss. Going from being responsible for everything and being a hands-on player in every aspect of the business to having employees to supervise and delegate is a giant leap. Most of us make the transition in stages, but even so we have to adapt to change or we could end up sabotaging the success we’ve worked so hard to build.

There’s lots of help out there. This is not a new issue, and the smartest business owners know the benefits of learning from someone else’s often costly mistakes. You can begin by looking in the business section of your bookstore (bricks and mortar or online) or check out courses or seminars that are available at local business associations, business schools or colleges in your area.

In the meantime, here are a few ideas to help you determine how your personality can help or hinder your transition, and some ideas on how to side-step some of the biggest traps.

If you are a natural go-getter and tend to have very strong ideas about what you want, there’s a fairly good chance you find delegating difficult. Entrusting decisions affecting your company to someone else is a challenge if you have been responsible for everything since start-up. For delegating to work at all, it is important to recognize that trusting someone to get the job done correctly means relinquishing the right to micromanage. Everyone has their own working style. Hire people you believe have the necessary talent and skills, provide clear direction on the outcome, budget and timeline, and then step aside. Be available to answer questions or provide feedback, but leave how to tackle the job up to them. Trust and confidence in your employees are key.

Good leaders are consistent. That doesn’t mean you don’t change marketing strategy if conditions merit it; but it does mean that when plans and strategies are set and the implementation has begun, you don’t change your mind mid-course without some very solid reasons.

Your team needs a strong sense of purpose. It is up to you to make sure employees know why the products or services the company produces are important, and how each person is critical to the company’s success. Also, your employees need to know where you stand on core beliefs and values, and what is expected of them. A leader must be up front with all employees.

Entrepreneurs have high expectations of themselves (and others), and so it’s easy to forget that recognition for a job well done is important in the workplace. Regular performance reviews, constructive feedback and consistent methods of measuring and rewarding success are important to your employees. The old saying “praise publicly; critique privately” never goes out of style. Impulsive outbursts or scathing criticism usually create long-lasting harm and might damage relationships with employees you wish to retain.

Learning to let go, to manage employees and to evolve into a first-class business leader is not an overnight transition. Those who succeed are entrepreneurs who recognize that long-term business success requires an open mind and a willingness to continue to learn new business skills.

Thursday, September 13, 2012

We all know to sidestep the misspelled email from a temporarily insolvent Nigerian prince who needs a little help and the details of our bank account. This type of clumsy email con typically goes out to millions of accounts hoping to trap a few unsuspecting recipients. The thieves sometimes highjack an official looking corporate logo or use official-sounding language, but a closer look usually reveals clues that something is just not right, such as spelling errors or odd language. Perhaps the most obvious tip-off is that the real sender would never ask a customer for this type of sensitive information via email.

Email fraud has become bolder and more sophisticated than these efforts. From broad-based mass mailings, cyber fraud is being committed by highly sophisticated criminals who use research to launch targeted cyber attacks also known as spear phishing – against targets that might include government agencies or major corporations. To give you an idea of the audacity of these criminals, a recent attack began with an email that appeared to be a legitimate inquiry from the Internal Revenue Service. Hackers have also used spear phishing tactics to crack into data files at a leading military contractor.

What characterizes spear phishing is that it is very well camouflaged. It appears to come from a colleague or trusted source and contains a plausible request. It looks authentic and can be very difficult for recipients to detect. In general, spear phishing has several distinct targets – major corporations, government organizations or individuals. Here are some examples of them.

Phishing messages to individuals will generally have some element of urgency – perhaps asking a recipient to handle a billing problem or an overdraft. Many of us pay our bills online, and although we would be suspicious of an email asking us to resend credit card or bank account data, we might click on a link to fix a billing mix-up involving our address. In doing so, we might be giving crooks the means to download malware that will relay passwords and other confidential information at a later date.

Sometimes, cyber-criminals target individuals using fake Gmail login screens hoping to find work emails that will enable them to enter a corporate email system. Targeting an individual who can provide entry into a much larger and more lucrative organization is known as whaling.

Cyber thieves will assume just about any identity to get the access they want. They create credible looking websites and communications purporting to be from respected organizations as varied as leading banks and social networks, to major government agencies including the IRS and the FBI. The goal is always the same – to rob businesses and individuals. Some of the scams pretending to be the IRS are amongst the nastiest. Timed to hit after filing deadlines, the scammers email victims – often small businesses and self-employed people – and advise them that their tax payments did not go through. Using the scare factor of the IRS name, these fraudsters have been quite successful despite the fact that the IRS never uses email to initiate contact and warns taxpayers on its website specifically about such scams.

Fighting Back

Leaders in the security industry admit it is hard to battle this level of sophistication. The industry is always playing catch-up, trying to stanch another leak in the dam. DMARC.org (Domain-Based Message Authentication, Reporting and Conformance) – a collaborative anti-phishing effort involving leading social networks and technology and financial services companies – is working to create better authentication systems to protect email domains. In the meantime, we must stay alert and recognize that we are all potential victims no matter how technically smart and business-savvy we are.

Tuesday, September 11, 2012

By early summer of this year, 30-year fixed mortgage rates had fallen to 3.55 percent – their lowest level in 40 years. One of the reasons rates have remained low is that investors continue to pour money into relatively safe Treasury bonds – the securities that guide home loans.

Up until recently, low mortgage rates weren’t as meaningful because the real mortgage rate had increased significantly. The RMR is the rate at which home prices are increasing higher than mortgage rates. It is calculated by subtracting the rate of a home’s appreciation or depreciation from the nominal mortgage rate. Ideally, you’d like your RMR to be in negative territory. For example, a 3.5 percent mortgage rate minus an 8 percent appreciation rate gives you a negative 4.5 percent real mortgage rate. That’s why no matter how low mortgage rates go, it doesn’t make sense to purchase real estate while prices are still dropping because you lose equity even as you close the deal.

However, a recent report from Zillow concludes that residential real estate has turned the proverbial corner and prices are poised to rise. Now that home prices are rebounding, the RMR is back in negative territory. This puts home buyers in the unique position to buy property while mortgage rates and prices are still low.

This favorable scenario, combined with new mortgage products designed to help bolster the industry, creates a good opportunity to buy or refinance for a better positioned mortgage down the road.

Assumable Mortgage

An assumable mortgage allows a buyer to assume the mortgage of the seller with the exact same terms. The buyer must go through the same application process in order to be approved by the lender to assume the balance of the mortgage with the same interest rate, payment schedule and remaining term at closing.

The reason an assumable mortgage is becoming more popular now is because interest rates are historically low. As they begin to rise, you will be able to offer your home for sale at today’s currently low rates, which will make your home more attractive than others on the market. Note that loans backed by the Federal Housing Authority are typically assumable for fixed-rate mortgages but not variable-rate mortgages and home equity lines of credit. Also be aware that if you are behind on payments, your lender’s agreement might disallow your assumable loan to be assigned to a new buyer.

Shorter-Term Mortgages

The Great Recession and its ensuing layoffs, salary freezes and market volatility have set many Baby Boomers back in their retirement savings plans. Refinancing can provide the opportunity to replace a current loan with a shorter-term mortgage so you can lower your interest rate and pay off your mortgage faster. In 2011, 34 percent of refinancers chose to replace their 30-year fixed-rate loan with a 15- or 20-year loan.

Rates on a 15-year loan are about one-quarter to one-half percent less than a 30-year term, but the savings can be dramatic. For example, refinancing a $100,000 mortgage to a 15-year term at a 3.75 percent rate would yield about $30,000 in interest savings compared to a 30-year loan. Plus, you can pay off the mortgage in half the time.

Customized Terms

To accommodate more recent demand for shorter-term mortgages, some lenders will allow you to choose the term you’d like for a mortgage, typically anywhere between 8 to 30 years. Especially for pre-retirees, this is a good opportunity to set your term to the date you want to retire – ensuring you’ll be mortgage-free at that time. It also allows homeowners to take advantage of today’s lower mortgage rates and lower home prices without having to assume another 15- or 30-year loan. A custom term positions you to pay off the new mortgage in the same time frame as your original mortgage.

Friday, September 7, 2012

With the presidential campaign getting into full swing, President Obama’s signature piece of legislation – the Patient Protection and Affordable Care Act, informally known as Obamacare – will come under increased scrutiny in the months ahead. Both sides will debate the Act’s implications, but its funding mechanisms are already in place.

The Supreme Court upheld the constitutionality of the PPACA on June 28 based on the federal government’s taxing power. The Act requires that all individuals not covered by an employer-sponsored health plan or a public insurance program to purchase health insurance or pay a penalty. In exchange, insurance companies are required to cover all applicants and offer the same rates to them, regardless of pre-existing conditions or gender. The Act will provide health insurance coverage for 32 million currently uninsured Americans.

The PPACA will be funded through a variety of fees, spending offsets and taxes. The fees include annual charges to health insurance providers and manufacturers and importers of branded drugs, while the spending offsets require reduced funding for Medicare Advantage policies, reduced Medicare home health care payments, and certain reduced Medicare hospital payments. The most debated funding mechanisms, however, are the increased taxes.

The PPACA imposes a 2.3 percent annual excise tax on manufacturers and importers of certain medical devices, which is intended to raise $20 billion over the next 10 years, according to the non-partisan Congressional Budget Office. The Act also calls for a 10 percent sales tax on indoor tanning services.

Individuals will face increased taxes on high-cost insurance policies, a reduced ability to use the medical expenses deduction on their tax forms, limited annual contributions to flexible spending arrangements for cafeteria plans, and for high-income taxpayers, an increased Medicare tax and a separate investment income tax.

Subscribers to high-cost insurance policies, or so-called Cadillac plans, will face a 40 percent excise tax on annual health insurance premiums over $10,200 for individuals and $27,500 for a family. That provision is intended to raise $32 billion over 10 years.

The adjusted gross income floor on the medical expenses deduction will be raised from 7.5 percent to 10 percent, meaning that only medical expenses that exceed 10 percent of the taxpayer’s adjusted gross income will be deductible. The CBO estimates it will raise $15.2 billion over 10 years.

The most common type of flexible spending arrangement for a cafeteria plan is the Medical Expense FSA, which allows an employee to set aside a portion of earnings to pay for qualified expenses, such as deductibles and copayments.
Previously, there was no federal limit on contributions to such a plan, although employers usually had a $5,000 annual ceiling. Under the PPACA, the annual contribution limit will be $2,500. The provision is effective Jan. 1, 2013, and will raise an estimated $13 billion over 10 years.

Finally, also effective Jan. 1, 2013, the PPACA imposes an additional Medicare tax of 0.9 percent and a new 3.8 percent tax on unearned investment income for single filers with income over $200,000 and joint filers with income in excess of $250,000. Most taxpayers currently pay 1.45 percent of their wages to support Medicare through the Medicare payroll tax. The new 0.9 percent increase will be imposed on wages in excess of the threshold amounts. The investment income tax targets dividends, interest, royalties, capital gains, annuities and rents for the same high-income taxpayers. These provisions are intended to raise by far the most revenue under the PPACA, at an estimated $210.2 billion over 10 years.

The CBO estimates that the PPACA will actually trim the federal budget deficit over the next 10 years. Voters will make their own decisions about the worthiness of the Act as they sort through the rhetoric from both sides in the presidential race.

Tuesday, September 4, 2012

Are you running a business or is it a hobby? Although in reality the lines may blur, it makes a big difference on your taxes.

According to the IRS, the incorrect deduction of hobby expenses accounts for a portion of $30 billion per year in unpaid taxes and is a frequent issue in IRS audits.
The IRS defines a hobby as an activity that is not engaged in with the expectation of making a profit, while a business is an activity carried out with a reasonable expectation of making one. When engaged in a hobby, a taxpayer can only deduct expenses up to the amount of income made from the hobby; and even then, hobby and other miscellaneous expenses itemized on Schedule A must add up to more than 2 percent of the taxpayer’s adjusted gross income before they are deductible.

On the other hand, a taxpayer can generally deduct all the ordinary and necessary expenses for conducting a trade or business. Taxpayers run into trouble when they deduct these business expenses and then discover that the IRS believes they are actually engaged in a hobby.

The IRS has two tests to determine whether an activity is a business or a hobby. First, it is presumed that an activity is being carried out for profit if the activity actually makes a profit during at least three of the last five years, including the current year.

If a taxpayer fails the profit test, then the IRS uses a facts and circumstances test to determine whether an activity constitutes a business. This test weighs several different factors that necessarily involve the judgment of IRS employees, but which can also suggest potential arguments a taxpayer might use when appealing the findings of an audit.

First, the IRS will try to determine whether the activity is carried out in a businesslike manner by looking at how records are kept, whether the taxpayer promotes the business, and if he or she tries to hold down costs as much as possible. Is there a business plan or an outline of when the taxpayer reasonably expects to make a profit? Is there a separate business bank account?

Second, does the time and effort put into the activity indicate the intention to make a profit? The IRS will try to determine whether the taxpayer depends on the income from the activity.

Third, if there are losses, are they due to circumstances beyond the taxpayer’s control or did they occur in the startup phase of the business? The IRS recognizes that many businesses do not expect to make a profit early in their life cycle, but they will want to see if the taxpayer has changed any methods of operation to improve profitability.
Fourth, the IRS will look at the taxpayer’s past. Has he or she made a profit from similar activities in the past? Does he or she have prior business experience? Does the taxpayer have the knowledge needed to carry on the activity as a successful business?

Finally, the IRS will look at whether the activity has made a profit in past years and whether there is a reasonable expectation of future profit from the appreciation of assets used in the activity.

Taxpayers often find themselves caught between a rock and a hard place in determining whether an activity is a business or a hobby. If you call it a business but don’t make a profit, you can’t deduct your business expenses. But if you call it a hobby and make money, then you owe taxes. Tax professionals can provide invaluable advice to help create the records necessary to support an argument that an activity constitutes a business, and they know the intricacies of IRS regulations so they can effectively represent you in an audit.